WEAKNESSES

RISK ASSESSMENT

Growth will be driven by domestic factors in 2016

Economic growth slowed in 2015 because of weakened demand from Brazil which representing 30% of its exports of goods. A one percent decline in Brazilian GDP reduces Paraguay’s economic growth by 0.5%. At the same time, the repeated droughts are hurting hydroelectric generation and the agriculture sector (soya, maize, wheat), which account for almost 90% of total Paraguayan exports. In this context, in April 2015 the government announced a plan to support domestic demand and economic activity. It specifically includes the launch of new infrastructure projects and increased social spending. Household incomes will continue to rise given the low rate of unemployment (5.5% of the labour force). The growth in 2016 will therefore be driven mainly by internal elements. However, the improvement of tax enforcement involves an enlargement of the tax base, but the results are slow to be felt. The 2016 budget drops to 0.9% against the previous year. Public sector wages have thus been frozen for the year.

In a context of falling oil prices and the appreciation of the guarani against the currencies of its leading partners, Brazil and Russia, inflation slowed significantly in 2015. The policy interest rate of the Central Bank was thus cut four times during the year, which also helped sustain private sector consumption through bank credit. Additional domestic demand as well as the moderation of commodity prices will revive inflationary pressures in 2016, but inflation will remain below the target at 5%.

Fiscal consolidation under way

Public finances are well managed and subject to the law on Fiscal Responsibility, effective in 2015, which places a limit of 1.5% of GDP on the deficit and limits the increase in current spending to 4% plus inflation. Thanks to the faster economic growth and spending cuts, the budget deficit will be smaller in 2016. Following its rapid expansion since 2013, the public debt will stabilise below the average level in Latin America (52% of GDP in 2014). Paraguay is also set to extend its tax base, one of the weakest in South America, in order to achieve its budget deficit objectives. The government is however facing public opposition. The lifting of the VAT (10%) exemption on loans taken out by cooperatives, which employ 1.3 million people, has thus been delayed for 6 months until April 2016 because of social discontent. Finally, the performance of state owned companies, operating in many sectors (ports, airports, telecommunication, cement and alcohol), are struggling from a lack of investment. In terms of the public finances these were estimated to account for 1.5% of GDP in 2014.

The current account will remain in deficit in 2016

The export sector is reliant on agricultural products for which international prices remain low. It is however more the slower rates of growth of its partners that will be a burden on the balance of trade, even though slightly in surplus, with Brazil and Russia (30% of soya exports) remaining in recession in 2016. Electricity exports (23% of exports in 2014) will suffer as a result of weak demand in its only two customers, Brazil and Argentina. In addition, the attractiveness of the country (tax exemptions, low VAT rate) supports FDI and thus, the repatriation of earnings by foreign companies will remain high (5% of GDP in 2014). Its currency reserves however are likely to remain satisfactory at around 6 months of imports of goods and services.

Resistance to the promised reforms

In post since August 2013, the President, Horacio Cortes (PC), is implementing an ambitious reform policy with the principal aims of reducing poverty, developing the agriculture sector and improving the effectiveness and transparency of the public sector. The Partido Colorado (PC) continues to hold the majority of municipalities, with 145 out of 250, but it suffered a reversal in the local elections of November 2015 and lost control of 5 major cities, including the capital, Asunción. The position of the PC -the majority party in the Chamber of Deputies but not in the Senate- would thus seem to have been weakened as dissidents are also emerging within its own ranks. Hence, the pace of reforms could decelerate.

Business climate remains difficult, in particular because of the size of the informal economy. The country is also one of the most corrupt in South America, after Venezuela. The former President, Federico Franco, has been the subject of criminal investigations since October 2015 for illicit enrichment, money laundering and criminal association. Finally, the inability of the government to effectively deal with the EPP guerilla movement in the north of the country is adding to the sense of insecurity and reducing the popularity of the PC.